Adam Smith was greatly surprised to know why water which is so very essential and useful to life has such a low price (indeed no price), while diamonds which are quite unnecessary, have such a high price. He could not resolve this water-diamond paradox. But modern economists can solve it with the aid of the concept of marginal utility. According to the modern economists, the total utility of a commodity does not determine the price of a commodity and it is the marginal utility which is crucially important determinant of price. Now, the water is available in abundant quantities so that its relative marginal utility is very low or even zero. Therefore, its price is low or zero. On the other hand, the diamonds are scarce and therefore their relative marginal utility is quite high and this is the reason why their prices are high. Prof. Samuelson explains this paradox of value in the following words:
The more there is of a commodity, the less the relative desirability of its last little unit becomes, even though its total usefulness grows as we get more of the commodity. So, it is obvious why a large amount of water has a low price or why air is actually a free good despite its vast usefulness. The many later units pull down the market value of all units. Besides, the Marshallian concept of consumer s surplus is based on the principle of diminishing marginal utility. Consumer ’ s Equilibrium: Principle of Equi-Marginal Utility: Principle of equi-marginal utility occupies an important place in cardinal utility analysis. It is through this principle that consumer s equilibrium is explained. A consumer has a given income which he has to spend on various goods he wants. Now, the question is how he would allocate his given money income among various goods, that is to say, what would be his equilibrium position in respect of the purchases of the various goods. It may be mentioned here that consumer is assumed to be rational , that is, he carefully calculates utilities and substitutes one good for another so as to maximise his utility or satisfaction. Suppose there are only two goods X and Y on which a consumer has to spend a given income. The consumer s behaviour will be governed by two factors first, the marginal utilities of the goods and secondly, the prices of two goods. Suppose the prices of the goods are given for the consumer. The law of equi-marginal utility states that the consumer will distribute his money income between the goods in such a way that the utility derived from the last rupee spent on each good is equal. In other words, consumer is in equilibrium position when marginal utility of money expenditure on each good is the same. Now, the marginal utility of money expenditure on a good is equal to the marginal utility of a good divided by the price of the good. In symbols, MUm = MUx / Px Where MUm is marginal utility of money expenditure and MUm is the marginal utility of X and Px is the price of X. The law of equi-marginal utility can therefore be stated thus: the consumer
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